Mike Khouw on a hedging strategy with the market at record highs and some threats emerging

Six months into the new Trump administration, the S&P 500 has reached an all-time high, with early Q3 earnings from approximately 10% of the Russell 3000 showing robust performance, including 10.9% average year-over-year earnings growth. Despite initial concerns about 'Trumponomics 2.0' and potential disruptions from tariffs, immigration policy, and Fed interference, the article suggests these have not yet significantly impacted corporate results. However, it highlights persistent deficit issues and elevated sector valuations, advising institutional investors to consider hedging strategies, such as purchasing put spreads on equity market proxies like SPY, given the current low VIX of 15 and historical September/October volatility.

Analysis

Six months into the current Trump administration, the S&P 500 has reached a new all-time high, a development that contrasts with earlier market anxieties surrounding 'Trumponomics 2.0'. This market strength is underpinned by robust early earnings data for the third quarter, with the approximately 10% of Russell 3000 companies that have reported showing average year-over-year earnings growth of 10.9% and a higher rate of revenue surprises. Key policy risks that were widely anticipated have not yet materialized into significant economic disruptions; the impact of potential tariffs remains uncertain, and the administration's immigration policies have not yet meaningfully impacted labor costs due to a slow pace of implementation. Similarly, while the White House has been critical of the Federal Reserve, the FOMC's committee structure is viewed as a bulwark against political interference. However, significant underlying risks persist, including unaddressed fiscal deficits and elevated equity valuations across most sectors, with healthcare noted as an exception. The current CBOE Volatility Index (VIX) reading of just over 15, below its 10-year average of 18.6, suggests a degree of market complacency heading into the historically volatile months of September and October.

Key Decisions for Investors

• Given the low VIX reading of just over 15 and approaching seasonal volatility, investors should consider adding portfolio hedges, such as the cost-effective put spreads on equity indices like the SPDR S&P 500 ETF Trust (SPY) suggested in the article.
• Re-evaluate sector exposures, potentially reducing positions in sectors with valuations well above historical averages while assessing opportunities in relatively cheaper areas, such as the mentioned healthcare sector.
• Closely monitor for any concrete developments in tariff implementation, immigration enforcement, and Federal Reserve policy, as these dormant risks could quickly re-emerge and disrupt the current positive market narrative.
• Scrutinize the remainder of the Q3 earnings season to confirm if the strong early trends, including 10.9% average earnings growth, persist across the broader market and listen for any changes in corporate guidance related to policy impacts.